Finding Growth In Canadian Pipelines

Includes: CNQ, ENB, PBNPF
by: Roger S. Conrad

For more than a century, few if any trends have been as inevitable and inexorable as rising global demand for electricity. Despite great leaps forward in efficiency, that’s virtually set in stone for the next hundred years, as developed and emerging economies alike continue to electrify.

Companies that produce and/or distribute power can stumble and fall--for example, from taking on too much debt or running afoul of regulators. And demand does occasionally drop, as it did in the US during the 2008-09 recession.

Even then, however, electric companies enjoy reliable revenue that’s the envy of every industry this side of regulated water utilities. And as long as they’re competently managed, earnings and dividends will hold up, no matter how bad things get elsewhere. The same holds true of companies that own and operate energy pipelines and related assets. As long as oil, gas and other refined products are flowing through their systems, they’ll make their money. And their revenues flow from perhaps the most financially powerful companies in the world: major producers of energy.

Even power and pipeline stocks can lose ground in a particularly rough market, as we saw in late 2008. The difference was that the damage was light, and they recovered quickly when the market bottomed. Moreover, those reliable revenues meant they could continue to pay and even increase their generous dividends, even as other companies seem to come unglued daily.

In my view, the likelihood of a reprise of 2008 is still quite remote. Europe continues to struggle with its sovereign debt crunch, and many of its economies are chronically weak. The US, meanwhile, is still locked in a pattern of slow and jagged economic growth, just as it’s been since the March 2009 bottom.

The 2008 meltdown, however, was only made possible by the hefty leverage throughout the system, as well as the fact that no one really knew who owned all those bad mortgage securities. Consequently, no one knew where the bombs were going to go off next, and the result was extreme uncertainty, high anxiety and abject panic.

In contrast, the amount of sovereign debt in circulation is well known. Many banks and financial institutions around the globe own it. But the vulnerable are also well known to monetary authorities, who in stark contrast to 2008, have had time to prepare a response should one falter. It’s also hard to argue that anyone is particularly leveraged in this environment. Rather, investors across the board continue to scurry to Treasuries--still the safe haven of last resort despite S&P’s dubious downgrade of Uncle Sam--every time the economic news seems to sour.

There just aren’t the types of bets out there that can create the kind of once-in-a-lifetime systemic crisis as happened in 2008. Rather, the most likely scenario for the rest of 2011 and into 2012 is just more of the same. Credit pressures will continue to keep a lid on economic growth, even as other factors--such as the lowest corporate borrowing rates ever--keep it creeping along. Should the economy go into reverse and credit markets tighten, however, power and pipeline stocks are the best bets to weather the storm. And that goes double for the picks that pay generous dividends in the Canadian dollar.

The loonie took a bath during the 2008-09 crisis, crashing from well over parity with the US dollar to just 76 US cents. That was largely a reaction to the plunge in the price of oil, which went from a mid-2008 high of over USD150 a barrel to less than USD30 at one point.

This time around, despite a drop in oil from USD115 to barely USD80 a barrel, the loonie has slid modestly. The markets appear to have finally recognized the country’s fiscal balance, rock-solid banking system and strong trade position--thanks to a bottomless appetite for its natural resources in emerging Asia, particularly China.

Of course, Canada did have these strengths during the 2008 crisis, which is why it suffered only a very mild recession. And these strengths will protect the country if there’s a global recession and market event in 2011, as so many seem to fear.

The difference is the strength the Canadian dollar is showing this time around; this means Canadian stocks aren’t likely to suffer nearly as much as last time, either. That’s particularly true for US investors, who saw their stocks lose twice as much ground in US dollar terms as they did on the home market in 2008.

Of course, growing businesses--not macroeconomic factors or currency strength--are by far the best guarantor that stocks will continue to build wealth and pay dividends. And here’s the real reason I’m long on select power and pipeline stocks here in September 2011: These stocks are in line for powerful long-term growth that will push up profits and ultimately dividends and share prices.

Whether or not Keystone XL is built, interest will continue to grow in exporting Canadian energy to Asia. The company pushing this forward is Enbridge (NYSE:ENB), with the backing of Chinese investors. The key project at this point is a proposed USD5.5 billion pipeline to bring 525,000 barrels of oil from the oil sands to the Pacific Coast for shipment to refineries in California and Asia. In contrast to the opposition to Keystone XL in the US, the roughly 730 mile proposed Northern Gateway pipeline enjoys strong support from Canadian provincial and federal leaders.

The most direct winner from additional infrastructure demand would be Pembina Pipeline Corp (OTC:PBNPF), which already has extensive projects in the oil sands and close relationships with both Syncrude and Canadian Natural Resources (NYSE:CNQ), the owner of the Horizon project.

Pembina should see a sizeable boost in cash flow in the second half of 2011, thanks to the on-time and on-budget startups of the Nipisi and Mitsue heavy oil pipelines. And the company continues to execute on several other projects. The expansion of its Cutbank Complex gas processing will be completed in mid-2012, with the entire capacity locked up under contracts with a minimum of five years. That’s the kind of low-risk, fee-based expansion Pembina has successfully executed for years. For more on Keystone XL and Pembina, check out this article.

Disclosure: I am long OTC:PBNPF.